Can tax cuts increase economic growth?

The current “debate” about tax cuts (actually, there appears to be more hand waving than debate but my parents taught me the virtue of politeness!) revolves around a central assertion: Tax cuts will spur economic and job growth. This assertion is based on the assumption that corporate and income tax cuts (many small businesses pay income rather than corporate taxes) will be reinvested into the economy spurring job growth. This is not entirely clear (https://www.bloomberg.com/news/articles/2017-11-29/trump-s-tax-promises-undercut-by-ceo-plans-to-reward-investors) but let us for the moment assume it will indeed happen.[1]

When businesses reinvest their capital, business grows and demand for labor goes up. Basic microeconomics does support this position. More capital increases labor productivity. Therefore, for a given supply of labor wages go up. Given the current tight labor market, this may indeed be the case. However, life is seldom static. The wage increase relative to the price of capital implies that new investment is likely to be capital intensive rather than labor intensive. This process actually exacerbates the current trend toward robots and away from labor. Thus, it is unclear if these tax cuts will increase job growth dramatically. In any case, these, fewer, new jobs will tend to benefit the sort of labor that can run robots and write algorithms. People with older/no skills will be left out in the cold. Such a scenario may create a permanent unemployable underclass if e.g. schools are unable to pick up the training slack.

The corporate tax cuts have other effects as well – particularly if these cuts lead to companies moving their tax headquarters back to the United States. This move will show up as a capital account surplus in the United States international balance of payments. This influx of foreign money increases the demand for USD and leads to an appreciation of the dollar relative to other currencies. The more expensive dollar makes our exports more expensive and our imports less expensive – thus increasing the trade deficit. This is not a problem per se but I have to scratch my head at the Trump administration’s inconsistency in pushing for a tax cut designed to increase the trade deficit when they want to reduce the trade deficit. To reiterate though, I do not think a trade deficit is a bad thing because foreign lenders MUST finance it. Therefore, it keeps interest rates low as well.  That can help future growth. Alternatively, if the US increased tariff/non-tariff barriers to cut the trade deficit the capital account surplus would have to go down – i.e. businesses would not bring capital into the country. This of course would cut off some of the growth benefits of the corporate tax cut.

Bottom line effects:

1. If the corporate tax cuts lead to capital reinvestment (and this is a big if) then labor productivity and wages will rise. This will lead to economic growth. However, job growth may not happen since firms will substitute labor with cheaper capital.
2. Jobs will be skewed toward specific skills. This will continue the current process toward jobs with specific skills and away from low-skilled/old-skill jobs.
3. Any attempt to lower the trade deficit will reduce the growth potential of the tax cuts.

[1] The income tax cuts are temporary. This may actually increase the incentive to pay out dividends which may then be taxed at lower income tax rates today rather than wait to be taxed at a higher rate I the future.